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Earnings Resiliency

Thurman Kelley

Brookmont believes that dividend investing is as much of an art as a science and that more emphasis should be placed on the ability of a company to grow cashflows than relying on past growth.

The proprietary Bookmont dividend score decomposes the evaluation of a company’s ability to sustain and grow their free cash flows and dividends into five components: Earnings Resiliency, Dividend Capacity, Management Commitment, Valuation and Dividend Legacy. Below we walk through our process and philosophy as it relates to Earnings Resiliency.

Earnings Resiliency is designed to capture how consistently a company has been able to grow their free cash flow and earnings over multiple market cycles.

The Sub-Components used to score the “Earnings Resiliency” section were crafted to create a risk/return profile that identifies companies that will have strong participation in a rising market and little-to-no participation in a declining market. The Sub-Components include:

 

Revenue Growth

The Long Term Revenue Growth of a company shows not only that the company is succeeding but also that there is a market appetite for the goods and services that it provides. The long term analysis of revenue growth will show how the company behaves during economic shocks, business cycles, and management changes.

 

Earnings Volatility

Earnings Volatility plays a big role in dividend investing because the dividend payout usually comes from earnings. A stable level of earnings is necessary for management to correctly forecast and plan for capital decisions. A large fluctuation in earnings makes the company much harder to manage and also shows signs of weaknesses within the company.

 

Net Income Growth and Margin Growth

Improving profitability over a period time is a great sign for a company and the long term prospects. This shows that the company can achieve economies of scale and will have the ability to continue that growth over time and thus improving the stock price and shareholder payout without proportionally increasing expenses.

 

EBITDA Margin Consistency

EBITDA Margin shows a company’s real performance because it is a company’s operating profit as a percentage of its revenue. The operating profit is the balance between revenue and expenses that management can control.

 

Return on Invested Capital (ROIC)

ROIC is the percentage return that a company earns on invested capital. Companies have to reinvest capital into the business to spur future growth and the ROIC shows how efficient those reinvestment dollars are for the company. A company with a high ROIC can drive future growth with less dollars and that creates a favorable metric for dividend investing because the shareholder can receive a good dividend payment without hindering future growth.

The length of a full business cycle tends to average around 5 years (4.7 to be exact). The reason that we use 10-year statistics is to shine a light of accuracy onto a company’s performance during both expansion and contraction of the economy for roughly the past 2 business cycles. It is crucial to include multiple cycles because business and market cycles each have their quirks and odd outperformers that do not represent long-term trends. A prime example of these odd performers would be Hertz in this most recent market cycle. (Rise of the Quarantined Day Trader).

ROE and ROIC are great metrics to assess the efficiency of the dollars being reinvested into the company as those will ultimately determine a company’s capacity for dividend growth and stock price for the long-term. All of these statistics can be easily calculated by any investment team but what makes Brookmont’s analysis different is that the Brookmont Research Team looks at what is driving these numbers and what other exogenous and endogenous factors can affect the trend line of a company’s earnings. Certain accounting adjustments are judgement based and reported metrics are often manipulated with bias, so the Brookmont Research Teams builds their own conservative models to assess a company’s financial strength.